Proposed regulation is all sizzle and no steak

INVESTORS trying to ensure they have a diverse portfolio of assets have probably dipped into the commodity markets at some point over the last two years. If you are thinking of doing the same, you need to be aware of changes to the regulatory landscape.

The Commodity Futures Trading Commission (CFTC) – the energy markets regulator in the US – is stepping up its effort to curb speculation in crude oil, gasoline, heating oil and natural gas futures contracts after the agency came under scrutiny when oil surged above $100 per barrel in 2008.

The CFTC has proposed an upper limit on the size of a position an investor can take. This means that a single investor could take a maximum position of 10 per cent of the first 25,000 open-interest contracts and 2.5 per cent of all contracts thereafter.

In simple terms, if the total number of open interest contracts in crude oil were 100,000, then you could purchase 2,500 of the first 25,000 contracts and 1,875 of the remaining 75,000. This limits the total number of contracts you can buy to 4,375, or just under 5 per cent.

These proposals, however, will not affect the vast majority of investors. The total value of open interest contracts in the crude oil market is $100bn. To come into violation of these proposed rules, one would have to own nearly $5bn of crude oil contracts, an amount beyond the financial clout of the average contracts for difference (CFDs) investor, points out Ole Hansen, head of CFDs and listed products at Saxo Bank. If these rules are implemented, he says they would only affect the 10 largest hedge funds and index trackers and therefore would have little impact.

One of the benefits of trading with CFDs is that investors are relatively protected from regulatory changes because they do not actually own anything. A CFD trade is based on the movements of the underlying asset and does not require you to take out a physical position.

For those companies that could be affected, it’s possible to avoid any changes to the CFTC rules. If a company needs to take a large position in the commodity markets they could simply use a European exchange instead.

Hansen calls the proposals a “symbolic gesture” from the CFTC, designed to be seen to curb “excessive” speculation after the oil price spiked to $147 per barrel in summer 2008. Over the past year oil prices have been fairly steady and not experienced any major periods of volatility. This could account for the low-key action taken by the CFTC. While the impact of these regulations is likely to be non-existent, it does point to a new trend of regulation across all markets in the aftermath of the financial crisis.

For now, the CFTC still has to get permission from the US Congress to be allowed to implement these changes. CFD traders should keep an eye on new regulation. Sooner or later, there will be something that affects you.